GWEN IFILL: More now about the root causes and potential implications of the day’s events, and to Margaret Warner.

MARGARET WARNER: And to help us understand that, I’m joined by Diane Swonk, chief economist at Mesirow Financial, a Chicago-based financial services firm; Nouriel Roubini, chairman of the consulting firm RGE Monitor, he’s also professor of economics at New York University’s Stern School of Business; and Kenneth Rogoff, professor of economics at Harvard University, he was chief economist at the International Monetary Fund from 2001 until 2003.

Welcome to all of you.

Diane Swonk, let me begin with you. Did the federal government, did the Treasury do the right thing this weekend, make the right decision not to prop up Lehman Brothers?

DIANE SWONK, Chief Economist, Mesirow Financial: I think that was the right decision, but I think there’s a one-two punch here. I mean, they did expand collateral. The Fed expanded the collateral they’ll accept. That it putting their actual balance sheet at risk.

Now that they’ve done that, if they really want that capital to be used to utilize those funds on Wall Street, they’re going to need to lower the Fed funds rate tomorrow and lower the discount rate tomorrow.

And I’m not positive they’re going to do that. I am hopeful that we do see a 50-basis point cut in the Fed funds rate tomorrow that will not only help to bring down the base level of interest rates for consumers, because those spreads are very high on mortgages out there now, but will more directly help to provide capital and make it very cheap for the existing financial firms on Wall Street.

Ongoing economic meltdown

Kenneth Rogoff

Harvard University

I think this is going to continue into other credit markets. And I suspect at some point you'll see the federal government back. But it was good to set a baseline, to say, 'You know, we're just not going to bail out everyone in America.'

KENNETH ROGOFF, Harvard University: Well, I absolutely agree with Diane. They did the right thing.

We already spent $29 billion on the Bear Stearns bailout. The government had taken on trillions of dollars of debt with Fannie Mae and Freddie Mac. And as John McCain said, it's a slippery slope if they did something here.

On the other hand, I don't know how long they're going to hang tough. I don't think it's over. I think this is going to continue into other credit markets. And I suspect at some point you'll see the federal government back.

But it was good to set a baseline, to say, "You know, we're just not going to bail out everyone in America."

MARGARET WARNER: Nouriel Roubini, do you share your colleagues' view that this was a good decision? And do you read Paulson's comments today about AIG as signaling essentially the same thing as far as AIG is concerned, that the federal government is not going to step in to save it?

NOURIEL ROUBINI, Chairman, RGE Monitor: I do agree that this was the right decision, because until now we've been in a process where profits are privatized and losses are socialized. So this was the right thing to do.

Unfortunately, this is the worst financial crisis we've experienced in the Unites States since the Great Depression. Even Alan Greenspan says this is once-in-a-century phenomenon. So things are getting worse.

The left hand is of banks going belly-up. Most of the growth is going to disappear. Insurance companies are in trouble. There is no light at the end of the tunnel.

And now there is a vicious circle, with the real economy contracting and the financial sector contracting, and everything is feeding on each other. So this is a very severe financial and economic crisis, and we're in the middle of a recession.

MARGARET WARNER: And, Diane Swonk, do you share that view that we're not at the end of this, this is not bottom? And if so, where do you think we are in the meltdown?

DIANE SWONK: We're not at bottom; I do share that view. I think the economy is going to get worse before it gets better. In fact, the only way by our analysis you could even flat-line on consumer spending and not contract is if oil fell to $75 per barrel by the end of September and stayed there through the end of the year.

So we're going into a very hard holiday season. Consumers have a lot of weight on their shoulder. And they don't have a lot of access to credit.

That's why I really think it's critical that the Fed steps in here. I also think, though, that there might be a bit of a light at the end of the tunnel. As foreign economies are weakening, as well, we're finally seeing a sort of 180 reversal by foreign central banks.

I think we are going to see the European Central Bank lower rates before the end of the year, as well, which is going to start to help heal the system. It's not going to erase problems through 2009. I think we're talking about a 2010 before we feel like we've got any kind of real grounding, even though the economy might be technically expanding before then.

A 'severe crisis'

Nouriel Roubini

RGE Monitor

It's not just about housing. This is a severe economic and financial crisis. And the only light at the end of the tunnel so far is the one of the incoming train wreck, unfortunately.

MARGARET WARNER: Professor Rogoff, do you think it will be until 2010? Alan Greenspan said yesterday he thought -- he hoped the housing market would stabilize sometime in 2009. And that's what Paulson said today, too.

KENNETH ROGOFF: Well, I'd put a little bit of optimism after today in that they're at least admitting there's a problem. Until now, the government policy has been to lower interest rates, try to bail out a firm here and there, and think that somehow this is going to go away.

But the problem is our financial sector is bloated. There have been years of epic profits. They've become too big. They need to shrink. And the government can't support them all.

And by finally really acknowledging that this weekend, I mean, I think it's looking towards some healing. And I think we're certainly going to have a deeper recession as a result of this, but maybe we might come out a little faster.

On the other hand, I certainly don't think we'll be in good shape still by the middle of next year.

DIANE SWONK: Underscoring that, I just wanted to add, Japan never acknowledged its problems, and that's why they had over a decade, almost 15 years of problems. This is somewhat -- as hard as it is, at least realizing your problems is one step to solving them.

KENNETH ROGOFF: Absolutely.

MARGARET WARNER: And, Mr. Roubini, why don't you weigh in here? I mean, you've had a very bleak view for quite some time now. Are you willing to wager a prognosis here about when it will turn around?

NOURIEL ROUBINI: Unfortunately, I think we're going to have a very severe recession. It's going to last at least 18 months through the middle of next year. And this financial crisis is not going to be over anytime soon.

And the problems are not just problems of housing. Housing has not yet bottomed out. Home prices are going to fall for another 15 percent for a cumulative fall of 40 percent.

The problem was not just subprime mortgage. It was subprime mortgages, near-prime mortgages, prime mortgages, credit cards, auto loans, student loans, commercial real estate, muni bonds, leverage loans that finance deals that should have never occurred, and even a fat tail of the corporate system as a huge amount of junk bond debt is borderline unprofitable and is going to get in trouble.

We have the biggest housing and asset bubble and credit bubble in U.S. history. Now it's going to burst, and many institutions, households, home-builders, financial institutions, and corporations are going to go bust.

So it's not just about housing. This is a severe economic and financial crisis. And the only light at the end of the tunnel so far is the one of the incoming train wreck, unfortunately.

MARGARET WARNER: Professor Rogoff, are you -- how do you see it? Do you have such a bleak view of the fact that the root cause of this is a lot bigger than the housing and credit crunch?

KENNETH ROGOFF: Well, I'm not sure I can quite get to where Nouriel is on being that bleak. I mean, I think that's definitely a risk here.

The way I see things going is that the taxpayers can end up bailing out the system. And that's going to be what's going to put an end to it at some point, after they've sort of seen enough carnage. We've had the sacrificial lamb of Lehman Brothers.

We're going to end up having a huge cost to this. It's just staggering. It's unfair to have the taxpayers bail out these rich bankers, but I do think that's going to be the end game.

And I think it won't be quite like the Great Depression here, but this is certainly just an extraordinary event that we're witnessing, Lehman Brothers going under, Merrill Lynch disappearing. Only two investment banks left. It's just incredible.

Impact on the financial system

Diane Swonk

Mesirow Financial

We forget that we're in a global economy. If this had happened 15 or 20 years ago, I think the repercussions would have been closer to the complete and utter meltdown scenarios that Nouriel gets to.

MARGARET WARNER: What does this mean, Diane Swonk? What is the impact on the nation's financial system when you have, really, in New York now down to just two of the five major investment banking houses?

DIANE SWONK: Well, you know, it's interesting, because we forget that we're in a global economy. If this had happened 15 or 20 years ago, I think the repercussions would have been closer to the complete and utter meltdown scenarios that Nouriel gets to, so I don't quite get as far as Nouriel does, either, because we're in a global economy with global investment banks.

And there's a lot of niche players. I have to admit, I happen to work for a company that's on the other side of this game. We've picked up an enormous amount of talent from Bear Stearns and hope to get even more talent, hiring workers today that might not have looked at us as a regional player or as a national player that's a privately held financial services firm.

We do do investment banking, and we do a lot of the same kind of financial services. So it's really been an opportunity for us. So I think those offsets are often underestimated, in terms of the reaction function for the overall financial services system.

MARGARET WARNER: And, Nouriel Roubini, what do you think is the likely impact on Wall Street and really the implications for Wall Street of what happened today, in terms of the way it operates, the way it does business? I mean, is Diane Swonk right that there's enough diversification out there globally and also regionally to just fill in?

NOURIEL ROUBINI: First of all, globally, at this point it's not just the U.S. recession. The latest data from Japan, from Canada, from Europe, from the U.K. are suggesting the world economy, the advanced economies are contracting. Fifty percent of global GDP now is in recession territory.

And soon enough, we're going to have a significant slowdown of growth also in emerging markets, so there is a risk of a global recession. And it's true that Wall Street is going to change radically. Three out of the five investment banks are gone.

And in my view, Goldman Sachs and Morgan Stanley should find another partner and do what Merrill has done, because they may not be able to survive. They borrow short term. They're highly leveraged. They lend long.

And, therefore, they're subject to the same risk of a bank run like any bank, but they don't have access to deposit insurance and have only limited access to the lender of last resort support of the Fed.

So Wall Street is going to change. Hundreds of smaller banks and medium-sized are going to go bankrupt. It's going to be a completely different financial system.

But in the meanwhile, the collateral damage from Wall Street to Main Street is going to be severe. That's the risk right now, that the collateral damage is going to imply a more severe recession, where the credit contraction and the financial losses are going to hurt jobs, incomes, and the overall economy.

MARGARET WARNER: Diane Swonk, do you agree that it will be harder now for businesses to raise capital to expand, to hire?

DIANE SWONK: Well, that's why I think the Fed needs to actually lower interest rates. Yes, we are seeing the credit crunch worsen, and that's why all of us are very pessimistic in the near term that the U.S. economy will get worse before it gets better. And I think that's very important.

With that said, you know, I just see the diversification. I was in banking for 19 years. And I will tell you, if this had happened in 1990 to this degree -- and we had a crisis in the early 1990s that was fairly substantial -- the consequences would have been even greater.

I think our system is fundamentally stronger today. And I am seeing the shock absorbers not on Wall Street. My world isn't Wall Street-centric; it's more Main Street-centric.

I'm seeing companies that have incredible amount of cash on their balance sheets, and we actually own part of a bank that is the fastest-growing bank in the country right now. It's part of the old LaSalle Bank that Bank of America bought. We took all their senior managers. And guess what? We're gaining market share.

A need for regulation

Kenneth Rogoff

Harvard University

We could require banks and financial institutions to have more of their own cash supporting their investments, a higher capital ratio is the jargon. We also would like their investments to be more transparent.

MARGARET WARNER: Professor Rogoff, there's a lot of talk today about new regulation or needing a different regulatory structure. And I know that's down the road some, because Congress has to deal with that.

But if you look at what happened today, are there some clear regulatory changes that, had they been instituted, would have prevented this or cushioned it?

KENNETH ROGOFF: Well, I think there are a couple simple changes that would have been helpful. We could require banks and financial institutions to have more of their own cash supporting their investments, a higher capital ratio is the jargon.

We also would like their investments to be more transparent. They were making these trades from one investment bank to another that only rocket scientists could understand. And when it went south, you know, it didn't work out very well.

But that said, I think a great thing about the fact that the Treasury and the Federal Reserve walked away from Lehman is they're putting some discipline in the market. Stockholders, bondholders, they know they've got to look at these firms. The federal government is not going to always bail them out.

So even if, as I think, the federal government is going to come in big later on, they at least have some discipline and maybe not quite so much need for regulation, which could end up throwing out the baby with the bathwater.

MARGARET WARNER: And, Nouriel Roubini, a brief final word from you about the need for more regulation. Where do you come down on that?

NOURIEL ROUBINI: Well, in the last few years, the approach has been the one of laissez-faire. And financial markets without appropriate rules and regulations are like the law of the jungle. It gets crazy, mania, panics, asset bubbles, credit bubbles.

So self-regulation means no regulation. Market discipline does not work. So I think the pendulum is swaying too much in the direction of self-regulation, and it was known we were there. Now we have to move towards appropriate rules, not excessive rules, but strong regulation, supervision of finance system. That's what's necessary.

MARGARET WARNER: Diane Swonk, a very brief, final word from you on need for more regulation?

DIANE SWONK: You know, it really is underscoring the same thing, the need for more regulation and transparency, but not throwing the baby out with the bathwater.

We really already made this mistake once in the wake of Enron. We don't need to -- we're always regulating yesterday's problems and that just opens the door to new problems down the road.

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